Personal Finance: Investors romping in the sandbox

photo Chris Hopkins

This year's hot investment commodity isn't gold, silver, corn or soybeans. It's sand. Thanks to the bonanza in North American oil and gas production, high quality sand is in short supply, and investors have been raking in outsized returns as a result.

Sand has always been a critical industrial mineral, reaching back to Roman times as a constituent of concrete for buildings and aqueducts. Until around 2008, glassmaking was the top user of industrial sand, followed by construction and foundry production. No more. Today, oil and gas production ranks number one, well ahead of any other use, and is poised to double its consumption over the next few years.

Two concurrent technological advancements have yielded this hydrocarbonaceous bounty: horizontal drilling and hydraulic fracturing. Exploration companies now routinely drill down over a mile and then steer the drill bit horizontally to distances of up to 10,000 feet. They then inject water, a small amount of chemicals, and a huge quantity of sand into the bore under high pressure to fracture or "frack" the rock. This allows trapped oil and gas to escape back up the well bore and eventually into your gas tank.

The role of sand is critical. Called a "proppant," the sand mechanically props the newly created fissures open to allow continued flow of oil and gas out of the rock. Drillers use a lot of it, and plan to use even more in the future.

While sand is certainly abundant in North America, the variety best suited for fracking possesses certain properties that make it rarer. The best grade for hydraulic fracturing is Northern White sand, composed of quartz crystals that are relatively round and hold up well to crushing forces. This particular grade comes mostly from mines in Wisconsin, Minnesota and Illinois. In the sand pits of those Northern states, business is booming.

Wisconsin, for example, had 10 operating sand mines in 2010. Today there are 124 operating or newly permitted mines in the state. Large producers now routinely dispatch so-called unit trains, consisting of 80 to 100 carloads of nothing but sand, and send them nonstop to the shale plays in North Dakota, Texas and Pennsylvania to keep the oil flowing.

Market research firm PacWest estimates that total fracking sand usage will more than double, from 25 million tons in 2011 to 110 million tons by 2015. And this forecast may underestimate the actual demand, as drillers are finding that more sand per well increases output proportionately. Just one year ago, an average of 2,500 tons of sand was pumped down each well; today it is more than 5,000 tons per well. To put that in perspective, an average frack today consumes 40 to 50 railcar loads of the stuff.

Investors in the sandbox have been amply rewarded. The three publicly traded mining companies are booking record sales and have seen their stock prices soar this year. Stock in US Silica, the largest producer, has gained 104 percent this year. Hi-Crush L.P. pays a 3.7 percent dividend and has rallied 62 percent year to date, while Emerge Energy Services yields 4.2 percent and is up 180 percent this year. All three have large operations in Wisconsin, the nation's new sand basket, and forecast strong demand growth ahead. Move over, cheeseheads.

Chris Hopkins is a vice president for Barnett & Co. Investment Advisors.